Lack Of Cannabis Banking Hurts Average Small Business Owners, While Wealthy Entrepreneurs Flourish

An employee of A Greener Today, a retail cannabis business in Seattle, holds cash next to one of the store’s safes in this 2014 file photo (Photo by Gilles Mingasson/Getty Images).

Most people think cash stacking up in vaults is the biggest problem caused by the cannabis industry’s lack of access to institutional banking. That is a problem, as it creates real concerns for public safety, as well as makes the industry harder to track and more ripe for illicit market diversion and money laundering.

But the lack of banking services for cannabis businesses has much more far-reaching implications that do not garner as much attention—but should.

Banking restrictions are effectively blocking nearly everyone but the wealthy and well-connected from getting into and benefitting from what is the fastest-growing industry in the country. They also are a serious roadblock to any efforts to make this industry and its wealth creation accessible to entrepreneurs from disadvantaged and minority communities that have historically borne the brunt of the failed War on Drugs.

Consider that the costs associated with launching a state-legal vertically integrated cannabis business, including the application costs, licensing fees, and startup costs, are in the neighborhood of $4 million to $6 million, at a minimum. Even opening and operating a retail dispensary to cash flow break-even costs in the range of $1 million to $2 million.

In any other industry, a small-business owner could simply go to a bank and get a business loan to fund the build out and early operating costs. In this typical scenario, the small business owner retains ownership of the business and, once the business is open, uses cash flow to pay off the loan.

However, that’s not what we’re seeing play out in the cannabis industry. Without access to traditional business loans, entrepreneurs who are not wealthy but want to start a cannabis business in their community are forced to raise money from investors and, in many cases, cede majority ownership of the business to those investors.

Needless to say, your average mom-and-pop dispensary operator or infused-products manufacturer doesn’t have a large network of high-net-worth individuals to call on. That’s not true, however, for the former corporate executives and Wall Street managers entering the cannabis industry who have Rolodexes full of wealthy friends and contacts who might be looking for investments in this new and growing industry.

This helps explain why so many license winners find it so much more difficult to raise capital than their better-funded national counterparts. By way of example, many groups that were granted licenses in the first application round in Massachusetts in 2014 are still not open today, largely due to the inability to find the $4 million to $6 million minimum needed for a large-scale vertically integrated cannabis operation.

This situation is also the reason why many of the largest and most successful companies in the cannabis industry have been started by or have the backing of previously successful and wealthy individuals:

GTI’s CEO, Ben Kovler, is a scion of Jim Beam family wealth.

Columbia Care was started by Wall Street executives with initial investment rumored to have come from some of the wealthiest individuals in the world.

MedMen is backed by John Zorbas and financial firm Captor Capital.

NETA, Massachusetts’ largest dispensary operator, is partially owned and initially funded by the wealthy Kessler family.

SeaHunter, iAnthus, Acreage and my own company 4Front were at least partially founded by former Wall Street veterans with access to networks of high-net-worth individuals.

While all of these companies, including my own, have been disadvantaged by the lack of access to institutional investors and banking services, they have a distinct advantage in the marketplace over the average small-business owner who lacks a family fortune or Wall Street pedigree and for whom accessing the necessary capital is incredibly daunting.

Thankfully, there are some promising efforts underway on Capitol Hill to fix this problem. A new bipartisan bill that would ease restrictions on the ability of banks to service cannabis businesses introduced by Sen. Cory Gardner (R-Colo.) and Sen. Elizabeth Warren (D-Mass.) is gaining traction. The legislation would amend the Controlled Substances Act so that it no longer applies to those following a state law related to the manufacturing, production, possession, distribution, dispensation or delivery of cannabis. President Trump has voiced support for this bill.

Another promising sign that we’re moving toward a future where state-legal cannabis businesses could access banking services: The Independent Community Bankers of America recently sent a letter to Congress praising HR 2215, which is a bipartisan bill introduced this spring that would prevent the government from punishing a bank that services the cannabis industry. This is important because the ICBA has significant influence with Republicans and Democrats.

But until legislative changes are made and banks no longer have to fear losing their charter for servicing businesses that deal with federally illegal substances, cannabis entrepreneurs will face a significant challenge raising enough capital to get open.

Without access to lending, the people who are awarded operating licenses in state-legal markets must take on dilutive capital, selling off pieces of the company every time they are granted a license and need to fund capital expenditures for a buildout and startup costs. This impacts the largest companies in the sector, who typically wind up owning less of their business than their counterparts in other industries. But it hits the smaller operators particularly hard.

This is not to say that investors in the cannabis space are being predatory. In fact, their desire for equity investments and returns are perfectly reasonable. Financial institutions can lend money at relatively low interest rates because they have hundreds of millions, sometimes billions to invest, allowing these interest rates to accumulate into large returns. Individuals with a few million dollars of their own money to invest are understandably looking for a much larger return on their money, something that can only come through an equity stake that has the potential to provide a return of 5-10x or higher if and when the company is eventually sold. Given the risk that they take investing in a federally illegal business, it is understandable that they would want more than a single-digit interest rate on a loan.

Undermining Equity Programs

Much attention has been paid in the press to attempts in Massachusetts, California, and elsewhere to provide licenses to “equity applicants,” essentially people from disadvantaged backgrounds and communities who have been traditionally targeted by law enforcement for marijuana arrests. And rightly so. Marijuana prohibition has been largely carried out against people of color in low-income communities. Providing a pathway to participation in the new legal cannabis industry is the right thing to do. If we exclude the very people who have been most impacted by prohibition from participating in the new legal market, we will have failed in ending prohibition in a way that corrects one of the largest injustices of the failed War on Drugs.

But I’m going to make a bold claim: Equity programs, no matter how well intentioned, won’t work as intended until banking gets fixed

Without access to banking and traditional lending, many of these equity applicants are going to face a major challenge. Once granted a license, they will need to find individuals willing to invest millions to get the business operational. Without access to lending or a network of angel investors, many of these equity applicants will sadly never find investors and won’t get past the licensing stage of the process.

For those who do find investment, the capital will come at a very high cost, with most having to sell a majority interest in their businesses to afford the capital-intensive cost of getting operational.

Again, it is hard in these cases to blame the individual investors, who are being asked to step into a role that would normally be filled by lending institutions. From the investors’ perspective, they will be making a decision to invest a non-trivial portion of their personal money into the business, and understandably want to have the ability to protect their investment in an industry that is still illegal under federal law.

In most cases, they will be asked to invest in a license holder with no operating history in the legal cannabis industry, and in many cases no experience running a business at all. And since most equity applicants, like nearly all “mom-and-pop” operators, have little savings of their own to invest, investors may need to cover up to 100% of the operating capital. Faced with putting up nearly all of the capital in a business run by someone with little-to-no operating history, most investors will want to protect their investment by owning a majority interest in the business. Even when the license holder can negotiate maintaining operational control, something that often happens even when they sell a majority of the business, the investors will want the ability to replace the management team if they feel their investment is being mismanaged.

This is not to say that equity programs are not important. They are essential. Even under the scenario described above, an equity license holder who maintains even 20% of the ownership after all investment has been collected has been granted a source of genuine wealth creation that otherwise is generally unavailable to people in disadvantaged communities. A minority ownership position in a business with the potential to be valued at $10 million or above, something not unusual once successful cannabis operations are up and running, represents life-changing wealth for the license holder who was provided an opportunity through an equity licensing program.

But were traditional lending services available to these license holders, they would often emerge owning a majority interest in their companies, with significantly more wealth creation for them, their families, and their communities. Until the federal government fixes the banking issue and opens access to institutional lending, competing in the legal cannabis industry will continue to be an uphill battle for small-business owners.